Wallace (Wally) Forbes, CFA, was President of the Forbes Investors Advisory Institute (FIAI) from 1993 through 2014, the division of Forbes Media that publishes the Forbes Special Situation Survey, Forbes Investor and is responsible for the Forbes participation in the Forbes/CFA Institute Investment Course published by Wiley. He hosts an interview program with leading money managers that appears on the Investing section. Mr. Forbes, the youngest son of B. C. Forbes, founder of Forbes Magazine, served as Vice President and Director of Forbes, and President of Forbes Investors Advisory Institute, from 1964 to 1969. After leaving the company, he served as president and CEO of Standard Research Consultants, formerly a subsidiary of Standard and Poor’s Corporation. He subsequently was a founder and partner-in-charge of Benchmark Valuation Consultants, which merged with KPMG Peat Marwick in 1987. Both firms specialized in the business valuation field. He has also served as a director of both public and private companies and of educational and other non-profit organizations. He rejoined Forbes in 1996, once again as President of FIAI. He has authored or co-authored articles on the valuation of business enterprises and related subjects that have appeared in various business and professional publications, including Harvard Business Review, Business Horizons, Monthly Digest of Tax Articles, Management World, Family Advocate, YPO Enterprise, Chief Executive, and The Business Valuation Handbook. After graduating in 1949 from Princeton University with a degree in civil engineering, he served for five years in the U.S. Navy Civil Engineer Corps and was assigned to Seabee battalions (Navy construction battalions) in various overseas locations. After leaving the Navy, Mr. Forbes attended the Harvard Business School, and, upon graduation, was appointed a research associate in investment management and a member of the faculty. Mr. Forbes is a member of the New York Society of Security Analysts and holds the Chartered Financial Analyst designation.

In This Challenging Market Look For Companies Dedicated To Increasing Shareholder Value

Barbara Marcin: We continue to have a very slow-growing economy this year. And we have some headwinds ahead of us, of course. The sequester cuts are starting to take place. And at the moment it looks as though there’s been no real progress in coming to terms about putting together a budget and making cuts in a determined way. That’s what our politicians’ job is. But they do not have the ability to do it at the moment. So it looks as though we have some slowing coming to us in the first six to twelve months of this year. And from those cuts we have already seen the effects show up in the numbers posted by retailers for the last quarter of their year and in the comments of the companies that we’ve seen, they noted that the return of the payroll tax has taken some bite out of consumer pockets.

On the slightly positive side, we certainly have seen housing firm up. And at some point that is starting to create jobs in construction and agents and home goods perhaps, also. And that may be a helpful support for the economy over the next one, two, three years.

Also a big positive is the huge, horizontal drilling boom in the last several years has created a lot of new, natural gas discoveries and really flattened the price of natural gas and will apparently hold it down for a few years. That will supply a longer-term advantage.

We have heard from numerous of the companies’ comments over the last year that, because of this cheap energy advantage, they intend, on their next decision, to most likely put their plants and new industrial capacities in the United States. And they may even pull some back from markets that they had gone to that seemed to offer lower costs in the last few years. So there are some positives to balance these negatives. But it looks right now as though we will remain in a very low-growth environment. We think that’s the backdrop against which we’re investing over the next year or so.

Forbes: Well, unfortunately, not a lot of light of day at the moment.

Marcin: No, not a lot to get very excited about. Take a look at the overall valuation of the market. It’s trading at about a fourteen multiple of earnings, which is about in line with the very long-term average of fifteen. We’ve seen earnings growth come in strongly in the last few years.

That has been achieved without a lot of top-line growth. Companies have benefitted from less hiring and using more technology. And also maybe even as much as a third of earnings growth has come from companies re-financing and having lower interest rates, as well as using additional borrowing to fund tremendous share buyback programs to leverage earnings per share.

So earnings growth has peaked now for the next year or two, with earnings for the S&P 500 expected to grow in the low single digits year-over-year. And against this background, we think that the overall valuation of the market is somewhat mediocre. But we do think there’s good value in a number of companies that can be strong cash generators.

Specifically we look for companies with these qualities. They are already generating a lot of cash. They have prospects for earnings growth over the next few years and generally highlight this by paying a good dividend. They have the opportunity to grow that dividend. And also companies that manage for shareholder value. They look at their balance sheet and look at their operations and make specific decisions as to how to manage that. Most importantly, they are selling for low multiples to their cash and earnings.

Forbes: So you do see some lights in the cash-generating area of the companies that have a lot of cash?

Marcin: That’s right. I think there are companies that are determined to return value to shareholders. Even as some of them wait for stronger periods of growth, they have found ways to return cash to shareholders in the form of dividends, to feed longer-term prospects for growth and also to spinoff or separate assets in order to get a higher price on them for the shareholders. So some managers are finding good ways to do the best that they can with the assets that they have in order to improve their returns. And we like some of these.

Forbes: Good. Maybe you can name a few.

Marcin: Great. One of these is International Paper (NYSE: IP). Their management decided a couple of years ago to take a look at the assets and the slow-growing paper industry that the company was in and say, “What is the best way that we can use our balance sheet, our assets and our cash? The company is a very strong cash generator.”

So they determined to do a combination of actions to increase shareholder value. They’ve increased the dividends five times in the last few years. And at the same time they have used their cash to make purchases to feed longer-term growth. So they bought Temple-Inland a year-and-a-half ago and have integrated that.

And as a result, they have wound up with about 35% of the containerboard market, which has resulted in lower distribution costs for them. They have also made acquisitions or large investments in paper companies in China, Brazil and India. And these investments, starting out this year and next year, are going to add to cash flow and earnings.

And they’ve also added to investments in Russia which they’ve had for about ten years. So the company, at the same time that it is returning cash to shareholders, sold off non-core assets and used that cash to make acquisitions in order to seed growth.

Rather than looking at the developed markets, certainly the U.S. and Europe, which have very low, single- digit paper growth prospects, they instead looked outside the United States. They saw these faster-growing markets and have made good acquisitions there.

Forbes: Well, that makes a good deal of sense against the background you see.

Marcin: Yes. The dividend yield on the company today is about 2.7%. And we expect the company to continue to increase the payout as the earnings grow.

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